Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that AK Medical Holdings Limited (HKG:1789) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is AK Medical Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 AK Medical Holdings had CN¥63.4m of debt, an increase on CN¥33.1m, over one year. But it also has CN¥826.2m in cash to offset that, meaning it has CN¥762.7m net cash.

How Strong Is AK Medical Holdings' Balance Sheet?

The latest balance sheet data shows that AK Medical Holdings had liabilities of CN¥571.9m due within a year, and liabilities of CN¥111.6m falling due after that. Offsetting these obligations, it had cash of CN¥826.2m as well as receivables valued at CN¥610.3m due within 12 months. So it can boast CN¥753.0m more liquid assets than total liabilities.

It's good to see that AK Medical Holdings has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that AK Medical Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that AK Medical Holdings has seen its EBIT plunge 11% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine AK Medical Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. AK Medical Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, AK Medical Holdings created free cash flow amounting to 19% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case AK Medical Holdings has CN¥762.7m in net cash and a decent-looking balance sheet. So we don't have any problem with AK Medical Holdings's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of AK Medical Holdings's earnings per share history for free.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.